Warnings Lurk in the Euro Zone’s Current Account

Optimists see hopeful signs in the euro zone, not least because current-account deficits in the struggling member countries have been narrowing.

But there’s probably less to the good news than the data suggest.

The euro area’s collective current-account surplus is now the highest it’s been since the introduction of the single currency and is rising sharply.

Between the early 2000s and the financial crisis, the euro zone’s current-account balance tended to range within half a percentage point of zero. But in 2012, the euro zone’s current-account surplus hit 1.8% of GDP and this year it’s expected to rise to 2.3%, according to the International Monetary Fund.

Ostensibly that’s good news. After all, it means euro-zone countries are exporting their way to health. Right?

Actually, it’s probably less than encouraging on two grounds. One, it points to serious future trade tensions. And two, it might be a cyclical rather than a structural phenomenon. Which means that the same old problems are bound to arise again.

To see why, it’s important to dig into the national data and see what’s changed and what hasn’t.

Before the financial crisis, the euro zone’s trading position might have broadly been in balance with the rest of the world, but within the single currency area there were serious tensions.

In 2007, Germany had a huge current-account surplus worth 7.5% of GDP. Other core countries, like Finland, Austria and the Netherlands, also had very substantial surpluses.

To maintain balance with the rest of the world, those surpluses were having to be offset by huge deficits in the single currency’s booming non-core nations. Ireland was running a current-account deficit worth more than 5% of GDP. Spain’s was worth nearly 10% and Greece’s 15%.

But since the financial crisis, those deficits have shrunk significantly. This year, Greece is expected broadly to have a balanced trade position, Ireland is seen generating a surplus equivalent to 3.4% of GDP and Spain a surplus of 1.1%.

All positive, right?

Except there might be less to these reversals than meets the eye. Across the highly-indebted nations, the improved trade position has largely been the result of a collapse in imports as domestic demand crashed with the financial crisis and austerity, rather than by way of an increase in exports. Unless structural changes have been deep enough in these economies to improve export performance–which isn’t clear cut, years of supposed economic restructuring notwithstanding–an improvement in domestic demand with wider recovery could see these countries drop back into substantial current-account deficits.

And this wouldn’t entirely be their “fault”. That’s because the major source of euro-zone imbalance isn’t fecklessness across the strugglers but rather policies in the core that enforce excessively high domestic savings rates. In other words, Germany is at the heart of the single currency’s tensions.

Last year, Germany posted a current-account surplus worth 7% of GDP. This year, it’s expected to come in at 6.1% of GDP. The Dutch have a surplus worth 8.7% of GDP and Austria’s has been climbing again, and is forecast at 2.2% of GDP. Only Finland, among the core countries, is generating deficits.

Indeed, that’s why the euro zone’s trade position is climbing with respect to the rest of the world. With the single currency’s strugglers unable to offset Germany’s surplus, everybody else now has to.

With the rest of the world now unable to offset German imports with exports to other parts of the euro zone, they are adopting more aggressive trade policies. Just look at Japan’s massive fiscal and monetary efforts designed to weaken the yen and boost the competitiveness of its exporters.

Unless Germany adopts policies to boost domestic demand and cut its external position, global trade tensions will undoubtedly rise. Because insofar as an improving current account is good news for the euro zone, it’s bad news for everybody else.